Aon has estimated that global reinsurer capital has declined by 15%, or $100 billion, to $575 billion as at the end of December 2022, driven by substantial unrealised losses on investment portfolios.
According to Aon, most reinsurers reported significant premium growth in 2022 on the back of rate increases, robust demand and foreign exchange movements.
Underwriting performance was again impacted by above-average insured losses from natural catastrophes.
The dominant event was of course Hurricane Ian, which had an estimated cost of $52.5 billion as per Aon’s Impact Forecasting.
Still, most reinsurers posted positive results, which Aon suggests reflects the benefits of the shift in pricing and coverage seen in recent years. The net combined ratio across Aon’s Reinsurance Aggregate (the ARA) was 96.2%.
However, the firm states that capital markets were volatile in 2022, with uncertainty associated with Russia’s invasion of Ukraine weighing on sentiment and policymakers’ efforts to bring inflation down from 40-year highs, via sharp hikes in interest rates, prompting fears of recession.
Aon writes, “Ordinary investment yields stabilized, but total returns were heavily impacted by declines in asset values, driven by rising bond yields, widening credit spreads and declining equity markets.
“Consequently, it was a poor year for reinsurance sector earnings overall. The ARA posted a return on equity of 5.2% based on reported net income, which was well below the cost of equity.”
The firm continues, “However, this outcome is misleading as it only includes a portion of the mark-to-market losses seen in 2022. Based on total comprehensive income, the return on equity was -14.7%.
“Over the six years from 2017 to 2022, the ARA reported an average net combined ratio of 100.3% and an average return on equity of 5.9%.”
Aon explains that resultant pressure from investors and rating agencies, is one of the driving forces behind the hard market seen in recent property reinsurance renewals.
Further, valuation metrics have improved post-Hurricane Ian, as investors have reassessed the sector’s future earnings prospects, including the benefit of higher interest rates on investment returns.
The decline in asset values drove reported equity levels lower across the industry in 2022, with some of the world’s largest insurance and reinsurance groups showing the most significant effects.
Across the ARA, total equity fell by $41 billion, driven by $48 billion of unrealized losses.
“Management teams pointed to mismatches in the major accounting regimes, which require mark-to-market losses to be recognized immediately on the asset side, but prevent discounting to reflect the benefit of higher interest rates on the liability side,” Aon writes.
The firm continues, “Despite the reductions in reported equity, reinsurer capital adequacy generally remains strong under risk-based regulatory and rating agency capital models, which take a more economic view of the current situation.
“That said, sensitivity to major losses has increased and debt leverage tolerances are being tested in some cases.
“Furthermore, while it is recognized that bonds are generally held to maturity and that their value will recover as that date approaches (typically over 2-3 years), it may become necessary for reinsurers to sell them to raise liquidity in the wake of an extreme event, thereby crystallizing the loss.”
Aon suggests that new capital formation is currently limited, reflecting significant uncertainties in what has become a “very challenging risk environment.”
The firm notes that investors are concerned about the impact of climate change and inflation, but there are expectations that the prospect of higher returns will drive new allocations going forward, particularly as the benefit of higher pricing and interest rates becomes visible in earnings.
Aon concludes, “At the time of writing, there is nothing to suggest that reinsurer underwriting appetites, or investor interest in the reinsurance sector, will be materially impacted by the difficulties seen in the banking sector in March 2023.
“Movements in interest rates imply a modest underlying improvement in the book values of re/insurers reporting at the end of the first quarter.”